USD/JPY Price Forecast for 2026: Exploring the Power of the Carry Trade
Original article authored by Michael O’Brien for TradingNews.com
The USD/JPY currency pair is a central focal point in the foreign exchange (Forex) market, often acting as a barometer for global investor sentiment and macroeconomic policy divergence between the United States and Japan. As we look ahead to 2026, market participants are trying to assess how monetary policy directions, inflation dynamics, and global risk appetites could influence the trajectory of the USD/JPY exchange rate.
This forecast delves into the potential path of the currency pair over the next couple of years, with a particular emphasis on the role of the carry trade — a popular Forex strategy that takes advantage of interest rate differentials between currencies.
Understanding the Carry Trade: Why It Matters for USD/JPY
The carry trade plays a significant role in shaping USD/JPY dynamics. Forex traders borrow in low-interest-rate currencies, like the Japanese yen, and invest in higher-yielding currencies, like the US dollar. This strategy has historically driven demand for the USD/JPY pair when rate differentials widen. Key points include:
– The US dollar serves as the “high-yield” leg of the trade due to historically higher interest rates from the Federal Reserve.
– The Japanese yen remains one of the most popular funding currencies due to Japan’s persistently low or even negative interest rates.
– As long as the interest rate gap remains wide, carry traders may continue to back the USD against the JPY, resulting in upward pressure on the pair.
Past Examples of Carry Trade Dynamics
The power of the carry trade in influencing USD/JPY has been evident in several historical episodes:
– From 2005 to 2007, robust US growth and rising rates pushed the USD/JPY above 120 as investors leveraged the low-yield yen to buy dollars.
– During the 2008 global financial crisis, the unwind of carry trades spurred a massive appreciation of the yen, driving USD/JPY down sharply, in part due to risk-off flows.
– In the years following 2016, the Fed’s tightening cycle and Japan’s continued ultra-accommodative monetary policy once again encouraged carry strategies, leading to a steady recovery in USD/JPY.
Current Market Environment and the Road to 2026
Looking ahead, several macroeconomic and geopolitical forces are expected to affect the exchange rate between the US dollar and the Japanese yen. These include GDP growth trends, inflation expectations, and central bank monetary policy paths in both countries.
Factors Supporting USD Strength:
– The Federal Reserve has communicated its intent to maintain relatively elevated interest rates to combat structural inflation pressures in the United States. Even if rate cuts occur in 2025 or early 2026, US yields are likely to remain above those in Japan.
– The US economy has shown impressive resilience, driven by strong consumer spending, robust labor market activity, and solid corporate earnings.
– If political uncertainty or fiscal stimulus measures emerge, they could further push US yields higher compared to Japanese yields, reinforcing USD demand.
Factors Driving JPY Weakness:
– The Bank of Japan (BoJ) maintains one of the most dovish policy stances among major central banks, with limited action expected to raise interest rates significantly over the coming years.
– Japan continues to struggle with low inflation and weak demographic trends, which reduce economic velocity and dampen monetary tightening prospects.
– Structural capital outflows from Japan into foreign assets — including US Treasurys — limit upward pressure on the yen.
Projected Scenarios for USD/JPY in 2026
Economists and Forex strategists are evaluating multiple scenarios that could dictate the behavior of USD/JPY by 2026. These scenarios are informed by assumptions around central bank normalization trajectories, investor appetite for risk, changes in trade balances, and macroeconomic divergence.
Scenario 1: Carry Trade Continues to Dominate
If US interest rates stay well above Japan’s
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